While stocks are mildly higher over the past two months, high-yield bonds have fallen by more than 2 percent—and some say that presents an early warning for markets as a whole.
To Larry McDonald, head of U.S. strategy with Societe Generale's macro group, the underperformance of high-yield bonds is a "systemic risk indicator," showing the possibility of instabilities within the financial system.
After all, high-yield bonds tend to track stocks closely. Since they are much more sensitive to concerns about default than most fixed-income products—hence their high yields, and their more colorful "junk bond" moniker—they are much more levered to the business cycle and the state of the economy. That makes them similar to stocks.
One theory is that "cracks" show in the high-yield market before they appear in the stock market, making divergence between junk bonds and stocks an indicator for where the market is going next. Since junk bonds have been underperforming, the concern would be that stocks are next to fall.
"At the end of the day, the high yield market is less liquid than equities, so traders tend to be quicker with the trigger finger in terms of taking down risk," McDonald said. "That's why credit tends to lead equities."
On the other hand, the recent divergence might also be seen as a neutral or even positive indicator.